Realty, In­fra Cos Face Higher Tax Outgo Un­der New Rule

Mum­bai: Real es­tate and in­fra­struc­ture com­pa­nies, al­ready strug­gling with thin profit mar­gins, could see a sub­stan­tial fall in prof­its and a sig­nif­i­cant rise in tax li­a­bil­ity next year due to the ‘thin capitalisation’ con­cept un­veiled in the Union Bud­get for 2017-18.

The new rule will not al­low com­pa­nies to claim tax de­duc­tion for in­ter­est paid on for­eign debt above 30% of their EBITDA (earn­ings be­fore in­ter­est, tax, de­pre­ci­a­tion and amor­ti­sa­tion).

Ex­perts say the most hit would be real es­tate and in­fra­struc­ture com­pa­nies that have large chunk of in­ter­na­tional debt at project level or in their spe­cial pur­pose ve­hi­cles (SPVs).

The gov­ern­ment is ex­pected to cat­e­gorise in­vest­ments through non-con­vert­ible deben­tures (NCDs) and the div­i­dend paid on that also as debt.

Sev­eral real es­tate and in­fra­struc­ture com­pa­nies or SPVs that have high for­eign debt could be hit by the new rule, said Am­r­ish Shah, se­nior ad­vi­sor, trans­ac­tion tax, EY.

“How­ever, some of the com­pa­nies with high profit mar­gins will re­cover this within a cou­ple of years as they would carry for­ward the un­ab­sorbed in­ter­est,” he added.

Thin capitalisation con­cept would

ap­ply to all com­pa­nies oper­at­ing in In­dia be­gin­ning April 2017, in line with the Base Ero­sion and Profit Shift­ing (BEPS) frame­work, a global agree­ment with 15 ac­tion points to check tax avoid­ance by multi­na­tion­als. In­dia has al­ready adopted some of these points. Un­til now In­dian com­pa­nies used to ben­e­fit from div­i­dend dis­tri­bu­tion (or in­ter­est paid) to their in­vestors or debtors lo­cated abroad.

“Div­i­dend has DDT (div­i­dend dis­tri­bu­tion tax) and hence, pay­ing in­ter­est was the most tax-ef­fi­cient method to re­mit money out­side In­dia, since even tax with­hold­ing was el­i­gi­ble for tax credit un­like DDT. Hence, some com­pa­nies may look at re­work­ing their cap­i­tal struc­ture us­ing con­vert­ible in­stru­ments or sim­ply ad­just their coupon rates,” said Jee­nen­dra Bhan­dari, part­ner, MGB and Co LLP.

Typ­i­cally, EBITDA is profit be­fore any de­duc­tions. Most real es­tate com­pa­nies deduct in­ter­est paid on debt by sub­sidiaries or SPVs from their con­sol­i­dated EBITDA. As per the new rule, the in­ter­est de­duc­tion can­not be more than 30% of EBITDA.

“Cer­tain sec­tors, es­pe­cially real es­tate and in­fra­struc­ture, are highly lever­aged, and sig­nif­i­cant fund­ing is made by off­shore-re­lated parties. Since in­ter­est above 30% of EBITDA would not be al­lowed as de­duc­tion, these sec­tors would be most im­pacted,” said Ra­jesh H Gandhi, part­ner, Deloitte Hask­ins & Sells.

Real es­tate and in­fra­struc­ture sec­tors, which were suf­fer­ing from thin profit mar­gins, used to get most of their debt in­vest­ments through Cyprus. With the gov­ern­ment rene­go­ti­at­ing the tax treaty with Cyprus in 2016, all in­vest­ments com­ing through the coun­try would at­tract ad­di­tional tax from April 2017.